Demand Trends and Deflation Watch

Global Growth

According to the latest IMF Global Financial Stability Report, “Amid huge uncertainties, a disconnect between financial markets and the evolution of the real economy has emerged. High levels of debt may become unmanageable for some borrowers, and the losses resulting from insolvencies could test bank resilience in some countries.”

Euro Zone

Prices on goods and services in Germany in September have decreased by 0.2% year-on-year following zero inflation in August.

The Euro Zone has resorted to negative interest rates to spur growth. Keynesian economists believe such action results in a “liquidity trap“when businesses do not see demand and inflation expectations, they will not increase investment, resulting in fewer jobs and less consumption. Negative interest rates and deflation become mutually reinforcing, with both households and businesses hold cash, causing deflation and a liquidity shortage.


In September, China’s Producer Price Index or factory-gate prices fell 2.1% year-on-year while the Consumer Price Index rose 1.7% year-on-year, missing the forecast for a 1.8% growth following August’s 2.4% rise. 

US Jobs

If you look at the U-6 rate (“real unemployment rate”), as it accounts for those who are unemployed, underemployed, and discouraged workers, then the unemployment rate is 10.3% vs. the official (U-3) rate of 7.9%. However, according to ShadowStats the reality is if the unemployment rate included those out of work long-term who stopped looking (Pre-1994 methodology), the rate would be 26.9% which is comparable to the rates we saw during The Great Depression.

Most unemployment measures are declining while long-term unemployment is still rising. The number of long-term unemployed – people out of work for a period exceeding six months – has ballooned. According to the Bureau of Labor Statistics, around 2.4 million Americans were unemployed for 27 weeks or more in September, up 781,000 from the previous month. The last time we saw this kind of jump in long-term unemployment was during the Great Recession. As of August, the long-term unemployed made up 5.1% of the labor force. And if the long-term unemployment rate stays high, the general unemployment rate will stay high, too. If the previous recession is any indication, reducing long-term unemployment may take a long time. 

Small Businesses

According to a study by Brookings released last month, more than 420,000 small businesses have closed their doors permanently since the beginning of the pandemic. That represents a staggaring 7.1% of all small businesses. The report states that through August, more than 18% of all US. small businesses, and more than 27% in leisure and hospitality, had not reopened. Brookings estimates 4 million jobs in the small business sector have been lost and “that will only return with the creation of new businesses.”

Poverty and the Middle-Class

The poverty level for a household of five in the United States is now $30,680. To give you an idea of how close that is to the middle class, the Social Security office has calculated that 44.79% of American workers made less than $30,000 last year, 56.46% made less than $40,000, and 65.91% made less than $50,000. That means that close to half of US workers are close to or below the poverty line. 

US Inflation

September CPI rose 1.4% over the last 12 months. Core CPI was up 1.7%. The Underlying Inflation Gauge (UIG) “full data set” is estimated at 1.3%.

The standout inflation driver since the pandemic began has been used vehicles. Since February, used vehicle prices have gained 14%. In September alone, used vehicle prices spiked 7%. Even though preowned cars and trucks account for less than 3% of the total consumer price index, it “accounted for most of the monthly increase in the seasonally adjusted all items index,” according to the BLS. As the CPI chart shows, Core CPI excluding used vehicles and housing actually fell in September.

Many goods prices that had spiked earlier on have either stopped rising or have started falling. Appliance prices fell 2% in September, while housekeeping supplies prices fell 1%. 

Perhaps most notable is the reversal in meat prices which jumped more than 13% between February and June and are now less than 4% higher than February.

The bigger worry, however, is what’s happening with the prices of services. In education, for example, prices are either flat or in outright decline.

Overall, services prices excluding energy were flat in September, while the annual inflation rate has slowed markedly. 

According to Gary Shilling, “If you think serious inflation is coming, you don’t believe in the fundamental power of excess global supply to depress prices. With globalization, Western technology is combined with cheap Asian labor to produce a vast array of goods and, increasingly, services. But Asian consumers purchase only a fraction of what they produce. China’s consumer spending is just 39% of gross domestic product, compared with 68% in the U.S., resulting in a saving glut that is highly deflationary.”

Falling prices may seem good for consumers, but they won’t be appealing if they translate into lower revenues for businesses and lower incomes for workers and investors.

Global Deflation

It’s a club that more countries may soon be joining.

Major central banks around the globe might be engaged in a manic policy of monetary and public debt INflation, but DEflation is growing. This week, banks are reporting that corporate loan demand and personal credit card use are declining, and savings rates remain high. A declining social mood appears to be fueling private debt deflation. But it’s price deflation that is grabbing attention at the moment as more countries slide into declining consumer prices.

The chart below shows the list of countries around the world where consumer prices are declining on an annualized basis (price deflation). Germany, the Euro Area and Australia are three recent additions to the club. This list of 36 countries amounts to 19% of the 185 countries that monitors. Almost one fifth of the planet is experiencing declining consumer prices.

If we add in the countries where the annualized consumer price inflation is below 2% (considered by major central banks to be sub-optimal), the list of countries grows by 60 to 94. We can therefore state that 51% of the planet is experiencing sub-optimal – to the banks – consumer price changes.

We can refine the analysis to take out smaller nations and economies. Looking at the world’s major economies as defined by the G20 plus Netherlands, Spain, Switzerland and Singapore, we find that 29% of countries are experiencing price deflation and 66% have consumer price inflation running below 2%.

Secular Outlook for Stocks

The historical average for P/E has been in the range of 15 to 16,, depending upon the period used for the long-term average. The high range for P/E, under low and stable inflation rate conditions, has been 20 to 25. The low range for P/E, under high inflation or material deflation conditions, has been 5 to 10.

Going forward, we should expect a new paradigm. Slower growth drives the ranges for P/E lower, which will affect future assessments of fair value. Keep in mind that, had real economic growth averaged 2% instead of 3.3% over the past century, the historical average for P/E would have been near 11—not 15 or 16.

In the future, the fair value for P/E when the inflation rate is low will be 13 to 15. With average inflation, expect P/E to be near 11. During periods of high inflation and significant deflation, expect the low range for P/E to be 5 to 8.

This is not an extreme outlook. It is simply the quantification of concepts that nearly all investors use daily. As is commonly recognized, high-tech high growth stocks have higher P/Es; lower-growth household product companies have lower P/Es.